Chapter
13
Investing in Bonds
13.1 Evaluating Bonds
13.2 Buying and Selling Bonds
© 2010 South-Western, Cengage Learning
Lesson 13.1
Evaluating Bonds
GOALS
Discuss the features, types, and earnings
on corporate bonds.
Describe the different types of
government bonds.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 2
Corporate Bonds
Bonds are loans (debt) that must be
repaid at maturity.
Bondholders (those who invest in bonds)
receive interest twice a year.
When the bond matures on its maturity date,
it is repaid.
Bond maturities typically range from 1 to 30
years.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 3
Face Value
Face value is the amount the bondholder
will be repaid at maturity.
Face value is also referred to as par
value because the face value is the dollar
amount printed on the certificate.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 4
Features of Corporate Bonds
Corporate bonds are sold on the open
market through brokers, just like stocks.
Bonds are known as “fixed-income
investments.”
Fixed-income investments pay a specified
amount of interest on a regular schedule.
A bond’s interest does not go up and down.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 5
(continued)
Features of Corporate Bonds
A bond’s contract rate (also called its
interest rate) is the percentage of face
value that the bondholder will receive as
interest each year.
Usually, payments of half the annual interest
are made twice a year.
Interest received on corporate bonds is
taxable.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 6
(continued)
Features of Corporate Bonds
 Registered bond
 A registered bond is recorded in the owner’s name
by the issuing company.
 Interest checks for registered bonds are mailed
semiannually, directly to the bondholder.
 Today, most bonds are registered.
 Coupon bond
 A coupon bond (also called a bearer bond) is not
registered by the issuing company.
 To collect interest on a coupon bond, bondholders
must clip a coupon and then cash it in at a bank,
following the procedures outlined by the issuer.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 7
(continued)
Features of Corporate Bonds
A callable bond is a bond that the issuer
has the right to pay off (call back) before
its maturity date.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 8
Types of Corporate Bonds
Debentures
Secured bond
Convertible bonds
Chapter 13
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SLIDE 9
Debenture
A debenture is a corporate bond that is
based on the general creditworthiness of
the company.
The issuer does not pledge any specific
assets to assure repayment of the loan.
Debentures are considered unsecured
bonds.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 10
Secured Bond
 A secured bond, also called a mortgage bond,
is backed by specific assets which serve as
security to assure repayment of the debt.
 If the corporation fails to repay the loan as agreed,
the bondholder may claim the property used as
security for the debt.
 The asset most often used for security is real estate,
a building, or some other type of property.
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Convertible Bond
A convertible bond is a corporate bond
that can be converted to shares of
common stock.
If the bondholder converts to common stock,
the bond is no longer due and payable at
maturity.
Convertible bonds can be exchanged for a
certain number of common shares at a
specific price per share.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 12
Earnings on Corporate Bonds
All corporate bonds are issued with a
stated face value and fixed contract rate.
There is no compounding.
Half the annual amount of simple interest
is paid every six months.
While the interest rate on your bond is
fixed, the market price (what you could
sell it for) can change.
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© 2010 South-Western, Cengage Learning
SLIDE 13
Zero-Coupon Bonds
 A zero-coupon bond is sold at a deep discount,
makes no interest payments, and is redeemable for its
face value at maturity.
 These bonds may also be issued by the U.S.
government or municipalities.
 As the bond progresses toward maturity, it may
appreciate, or increase in value.
 The bondholders make money by selling the bonds
before maturity at a price higher than they paid for
them.
 Or, they can hold the bonds to maturity and receive the
face value and interest.
Chapter 13
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SLIDE 14
Government Bonds
Municipal bonds
Savings bonds
Treasury securities
Agency bonds
Chapter 13
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SLIDE 15
Municipal Bonds
 A bond issued by state and local governments
is called a municipal bond.
 Municipal bonds are also known as “munis.”
 Municipal bonds generally pay a lower interest
rate than corporate bonds.
 However, the interest is exempt from federal
taxes (and often state and local taxes as well),
so the effective rate is higher than the stated
rate.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 16
Types of Municipal Bonds
 A revenue bond is a municipal bond issued to
raise money for a public-works project.
 The revenues (income) generated by the project are
used to pay the interest and repay the bonds at
maturity.
 Major projects financed by revenue bonds include
airports, hospitals, toll roads, and public housing
facilities.
 A general obligation bond (or GO) is a
municipal bond backed by the power of the
issuing state or local government to levy taxes
to pay back the debt.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 17
Comparing Taxable
and Tax-Exempt Bonds
Corporate
Bond
Face Value (Principal)
Rate of Interest
Amount of Annual Interest
Tax on Interest Earned (28%)
Net Interest
$10,000
6%
$600
$168
$432
Municipal
Bond
$10,000
5%
$500
$0
$500
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© 2010 South-Western, Cengage Learning
SLIDE 18
Savings Bonds
You can buy U.S. savings bonds three
ways:
From commercial banks
Through payroll deduction plans
Directly from a Federal Reserve Bank
You can buy up to $20,000 worth of these
bonds a year.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 19
(continued)
Savings Bonds
 Series EE
 Series EE bonds are sold at one half of their face
value. Investors who buy these bonds often hold
them to maturity.
 These bonds are issued with maturity values that
range from $50 to $10,000.
 Series I
 Series I bonds are sold at face value and have fixed
plus variable rates of return that increase as general
interest rates rise.
 This helps protect you from the effects of rising
prices (inflation).
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© 2010 South-Western, Cengage Learning
SLIDE 20
Treasury Securities
Treasury securities are virtually risk-free,
since they have the backing of the U.S.
government.
They are taxable at the federal level but
are exempt from state and local taxes
and are usually not callable.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 21
(continued)
Treasury Securities
Types of treasury securities
Treasury notes
Treasury bills
Treasury bonds
These investments exist as bookkeeping
entries in the records of the U.S.
Treasury Department itself or in the
records of commercial banks.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 22
Agency Bonds
 When you purchase an agency bond, you are
loaning money to a federal agencies.
 Federal agencies that issue bonds include:
 Federal Home Loan Mortgage Corporation
(Freddie Mac)
 Federal National Mortgage Association
(Fannie Mae)
 Federal Housing Administration (FHA)
 Student Loan Marketing Association (Sallie Mae)
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 23
(continued)
Agency Bonds
The agencies use this funding to provide
low-cost financing to certain groups of
people.
Agency bonds are basically risk-free and
they offer a slightly higher yield than
securities issued by the Treasury.
Agency bonds are usually exempt from
state and local taxes, but not federal tax.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 24
Lesson 13.2
Buying and Selling Bonds
GOALS
Explain how to buy and sell bonds,
considering both risk and return.
Explain how to read the bond listings of
financial pages.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 25
Owning Bonds
Full-service broker
Discount broker
Banks
Federal Reserve System
Chapter 13
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SLIDE 26
Return on Bonds
 Earn interest for each day they own the bond.
 Redeem the bond for its face value at maturity.
 Bond redemption occurs when it is paid off at
maturity.
 The issuer of the bond pays back the original
amount that was borrowed.
 Sell a bond before maturity.
 Bonds often appreciate in value, especially when
interest rates are dropping.
 Bondholders may be able to sell the bond before
maturity for a price higher than they paid for it.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 27
(continued)
Return on Bonds
Bonds are a safer investment than many
other choices because they have a fixed
interest rate and represent a loan that the
issuer must repay.
Bond prices tend to remain steadier than
do stock prices.
Also, bond prices tend to react in the
opposite direction of stock prices.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 28
(continued)
Return on Bonds
Bond investments serve as a hedge to
help offset the risk of the stocks in your
portfolio.
A hedge is any investment or action that
helps offset against loss from another
investment or action.
Hedging is a tactic used to reduce overall
risk.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 29
Risk on Bonds
To help investors evaluate the risk level
of different bonds, independent rating
services rate bonds according to their
safety.
A bond rating tells the investor the risk
category that has been assigned to a
bond.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 30
(continued)
Risk on Bonds
Bond rating services base their ratings on
the financial condition of the issuing
corporation or municipality.
Bond default means that the bond
issuer cannot meet the interest and/or
principal payments.
Because bonds are not insured, investors
can lose their money if the corporation or
municipality defaults.
Chapter 13
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SLIDE 31
Investment-grade Bonds
A bond with a rating of Baa or higher in
Moody’s, or BBB or higher in Standard &
Poor’s, is considered an investmentgrade bond.
Investment-grade bonds are
considered the highest-quality, lowestrisk bonds.
The higher the bond’s rating, the lower
the interest rate you will earn.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 32
Junk Bond
 A junk bond has a low rating, or no rating at
all.
 Any bond with a rating of Ba/BB or lower is called a
junk bond.
 Because of its low or no rating, this type of bond is
highly speculative.
 In most cases, interest rates on junk bonds are
high because they are high risk, since the
companies issuing them are not financially
sound.
Chapter 13
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SLIDE 33
Bond Fund
 A bond fund is a group of bonds that have
been bundled together and sold in shares (like
stock) to investors.
 Typically, a bond fund would contain some
investment-grade bonds along with bonds of some
newer companies, foreign bonds, and a few junk
bonds as well.
 Mutual funds, brokers, and investment services at
financial institutions offer bond funds to their
customers as a method of hedging against the risk
of loss from other investments.
Chapter 13
© 2010 South-Western, Cengage Learning
SLIDE 34
Reading Corporate Bond Listings
Excerpt from stock exchange (bond) listings:
Mat.
3 p.m.
Bid
Net
Chg.
Yld
3
4
5
6
7
a/BB
9.125
12/08
98½
unch
9.46
b/B+
10.000
8/11
unch
9.57
Am Std
a/BB+
7.375
2/10
–1¼
7.56
Chanclr
b/BB+
8.125
12/09
103
unch
7.36
Echostar
a/B
9.375
2/11
101¼
unch
9.52
Name
Type/
Rating
Coup.
1
2
AK Steel
Allied Waste
102
98½
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© 2010 South-Western, Cengage Learning
SLIDE 35